Three Principles for Remuneration Policies

The annual financial reporting season for companies brings with it an annual preoccupation with executive salaries. The annual stoush will persist until company directors adopt three principles in setting remuneration policies.

Smaller investors, especially, have few ways in which to sheet home their discontent with the way a company might be performing. Remuneration is a tempting proxy against which to vent.

Regulators, displaying few clues as to how to measure corporate performance, have abetted the attack. Short of recognising catastrophic failure after the event, regulators and the framers of their legislative authorities are entirely bereft of any thought about how to measure business performance. From a position of simultaneous ignorance and determination to signal their investor friendliness, regulators have opened an annual window of discontent.

Meanwhile, company executives and directors have often appeared like deer in the headlights seemingly unable to justify remuneration levels with reference to the performance of the companies they manage. More frequently, the case for higher pay is based on a consultant report comparing so-called peer companies. This is an attractive option for directors who can use it to escape their responsibilities. Happily for all executives, this process implicitly underpins remuneration inflation.

The upshot is little consensus about how executive pay should be judged.

To avoid the intemperate reactions, annual confrontations and sneering press reports, three principles should be applied to setting executive pay scales.

Directors should clearly enunciate operational and strategic targets against which management can be judged. Critically, shareholders should be told what these are at a general meeting and the subsequent remuneration report should refer to them and score executives against their achievement.

Executives should not be granted shares or options. Investors are never "granted" shares. True alignment with shareholders - the holy grail to which directors constantly refer - requires executives to put up risk capital. Executives should buy shares from salary.

Executives should not be rewarded for macroeconomic changes over which they have no influence. A fall in interest rates leading to an expansion of price/earnings ratios or a surge in global growth leading to higher equity values are some of the risks taken by equity investors. There is no reason to reward executives for being fortuitous bystanders to changes in the world economy.

In short, executives should be rewarded for completing set tasks successfully. Companies should more closely tailor rewards to their specific circumstances.

These principles recognize the difference between the providers of equity and corporate managers. The equity providers forgo regular income for a more risky return related to a combination of business performance, interest rate movements and global growth. The first of these could frequently be the least important.

The tendency for managers to switch sides depending on where their return might be greater creates some of the hostility from shareholders. Controversy will surround remuneration practices as long as this free option persists and boards fail to differentiate between the different roles of equity providers and corporate managers.

If you liked this article and would like more by email, subscribe! It's free.

[Bold fields are required]

Your details

Your alternate email address is used only if messages to your primary email address are returned to us.

Mailing addressEmailAlternate emailFirst nameLast name

Industry

Do you work in the financial services industry?

Yes No

This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity.
Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.